On February 13, international benchmark Brent crude oil rose above $60 a barrel for the first time since late December, after nearly seven months of plunging prices from a peak of $115 a barrel in July.
“The new equilibrium price will be around where it is at the moment,” reckons Alasdair Cavalla, a macroeconomist at London’s Centre for Economics and Business Research (CEBR). Though it’s difficult to forecast prices in this type of market, he thinks the floor for Brent prices is around the current $60 level and will hover here through the end of 2016.
New York-based asset manager BlackRock also foresees a gentle recovery in prices, reaching $70 a barrel by 2017 but not topping $100 a barrel anytime soon, according to its February report, “Concentrated Pain, Widespread Gain: Dynamics of Lower Oil Prices.” The Organization of Petroleum Exporting Countries is no longer going to be the determinant of prices on the margin, and markets will self-equilibrate in the long-term, believes Gerardo Rodriguez, a New York-based emerging-markets portfolio manager at BlackRock and co-author of the report.
“What we’re facing right now is a complete change in paradigm in which a marginal determination of market prices would no longer be a function of the discussion in the OPEC environment and specifically the willingness of Saudi Arabia to do that [set prices],” he adds. The most flexible producers — shale oil producers — will play that role instead, he predicts. The reason: Shale producers can more quickly react to changes in price and supply.
These lower oil prices have proven to be a major boon for emerging-markets economies, 70 percent of which are major oil importers, says Nathan Griffiths, a senior portfolio manager for emerging-market equities at ING Investment Management in the Netherlands. The biggest winners, experts agree, are concentrated in Southeast Asia, where economies are rapidly growing and industrializing, and where there are fewer oil producers than in many other emerging markets such as in Africa, South America and the Middle East. Oil represents a third of all Indian imports, for instance, and India is the fourth-largest consumer of crude oil and petroleum in the world, according to the U.S. Energy Information Administration.
Cheaper oil reduces the cost of energy-intensive manufacturing and curbs inflation worldwide, putting more purchasing power in the pockets of consumers. “It offers prospects of stronger growth without inflation,” says Jeffrey Frankel, economics professor at Harvard University’s John F. Kennedy School of Government.
“Many oil importing countries are taking the opportunity of the decline in inflation to ease monetary policy,” says ING IM’s Griffiths. Cheaper oil gives central banks an extra tool to stimulate economic growth, agrees Cavalla of CEBR. Oil importers in developing nations, particularly in India and Indonesia, are vulnerable to high current account deficits, meaning they import a lot more than they export. Central banks usually defend against that by keeping interest rates relatively high to boost currency returns, he adds. India’s trading position has improved considerably as oil prices have fallen. Slowing wholesale price inflation of 0.11 percent in December, well below the expected consensus of 0.6 percent, prompted the Reserve Bank of India to cut interest rates by 25 basis points in January for the first time since March 2013. Asia’s third-largest economy surprised markets again on March 4 when the new government cut rates by another 25 basis points to 7.5 percent after delivering its first annual budget.
Arguably the most important upshot of lower-for-longer oil prices is the chance for governments to end ruinously expensive energy subsidies. “For the few countries that were subsidizing gasoline consumption, this is a very good opportunity to move toward market determining-type of prices,” says BlackRock’s Rodriguez. “The market has done a lot of the heavy lifting for governments.”
Countries have the opportunity to cut back on subsidies or remove them without the public’s feeling a heavy increase in prices.
Until recently, Indonesia, the most populous nation in Southeast Asia, was spending 13 percent of its budget on fuel subsidies, says CEBR’s Cavalla. “That’s a very high cost for a developing economy, especially one that really needs to build up infrastructure for long-term investment.” Removing subsidies frees up money for more-efficient government spending and better-balanced federal budgets and guides the long-term sustainability of government finances. Indonesia began trimming subsidies in 2013. Its new president, Joko Widodo, officially ended them on January 1. India, which used to spend $23 billion annually on fuel subsidies, halted diesel subsidies and raised fuel taxes in October 2014, and Malaysia, a net oil importer despite being the world’s second-largest liquified-natural-gas exporter, also cut gasoline and diesel subsidies in late 2014.
Harvard’s Frankel explains that once fuel subsidies have been put in place by governments, they are difficult to remove. “It’s been considered impossible, and it’s been considered politically a death knell for governments.” Those that have tried to cut back subsidies for oil in the past, such as Jordan in 2012, Sudan in 2013 and Cameroon in 2014, have faced unrest. Between June 2012, when Sudanese President Omar al-Bashir, encouraged by the International Monetary Fund, announced plans to scale back fuel subsidies, and September 2013, when they were removed entirely, more than 300 civilians were killed by police as thousands rallied for Bashir to step down. There has also been unrest in Indonesia and Malaysia following recent cuts, though consumers seem to be generally responding positively. “That’s the beauty of living with lower oil prices: You can move with sensible economic policy at a reduced political cost,” says BlackRock’s Rodriguez.
“When you have a big fall in the prices of essentials, like oil, that effectively acts as a huge tax cut for consumers,” contends Cavalla. Consumers have more to spend on discretionary goods now that their essentials are less expensive, which should provide a stimulus for big developed economies like the U.S.'s and Europe’s. “That in turn really helps developing countries because a lot of them rely on exporting to fuel their growth. The more that consumers in developed economies have to spare, the better that is for developing economies’ manufacturing sectors.”
Many of these economies have recently become more oil and commodity dependent, he continues, while it’s better for a developing country to focus on manufacturing and other exports that require skilled workers and have greater economic value. Shifting from commodity dependency is better for a country’s exchange earnings and cuts the reliance on the economies of big commodity consumers. “In the long term, if oil goes down and those countries move out of commodities, then it’s actually a very good move for their development overall,” he says.
The new normal of oil prices settling far below the four-year price of $105 per barrel also has implications for foreign investors. “The risk to investors is that causes of the decline are misunderstood and as a result drive poor investment decisions by having excessive expectations of the benefits and ignoring other impacts from factors such as the strong USD [U.S. dollar],” notes ING IM’s Griffiths. ING doesn’t believe the price drop was supply driven, as many commonly think. Instead factors like the rise in the U.S. dollar and the unwinding of investment in commodity funds played a significant role. “As a result, volatility will be high, and there is a good chance we test new lows before a base is found,” concludes Griffiths.
The main opportunities for investors lie in those sectors that will directly and indirectly benefit and can retain the benefits, like airlines and manufacturing. Cavalla adds that cheaper oil makes oil-importing emerging-markets countries safer overall to invest in because their exchange rates should now be on a firmer footing. The private sector will be involved in a lot of the infrastructure plans that are being pursued in developing countries because that’s often the best source of capital.
“Even when the U.S. is at an inflection point and is moving towards normalizing monetary policy, you can see that there is this wave of easing that lower oil prices are bringing to the table, and that has important implications for fixed income and equity investors,” says Rodriguez, who spent 15 years at the Mexican Ministry of Finance focusing on fiscal policy and financial market development. It is at this point in monetary policy cycles that you can find good investment opportunities, he says.
Lower oil prices produce a clear list of winners and losers, particularly in emerging markets, but in total, experts agree that it’s a positive sign for the global economy. “In aggregate, a weak oil price is clearly beneficial to emerging markets, and will partly reduce systemic risks from weak trade balances for the importers,” says Griffiths of ING IM.
